Erroneous Distribution Provisions
Background
In response to a recent Revlon syndicated loan dispute, industry groups such as the Loan Syndication and Trading Association (LSTA) and the Loan Market Association (LMA) as well as individual lending institutions have now developed model language intended to protect administrative agents against potential liabilities arising from any payments made in error.
Example
Erroneous Distributions. “Each Lender hereby agrees that (i) if the Administrative Agent notifies such Lender that the Administrative Agent has determined in its sole discretion that any funds received by such Lender from the Administrative Agent or any of its Affiliates were erroneously transmitted to, or otherwise erroneously or mistakenly received by, such Lender (whether or not known to such Lender) and demands the return of such Erroneous Payment, such Lender shall promptly, but in no event later than one Business Day thereafter, return to the Administrative Agent the amount of any such Erroneous Payment (or portion thereof) as to which such a demand was made, in same day funds (in the currency so received), together with interest thereon in respect of each day from and including the date such Erroneous Payment (or portion thereof) was received by such Lender to the date such amount is repaid to the Administrative Agent in same day funds at the greater of the Federal Funds Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank compensation from time to time in effect and (ii) to the extent permitted by applicable law, such Lender shall not assert any right or claim to the Erroneous Payment, and hereby waives, any claim, counterclaim, defense or right of set-off or recoupment with respect to any demand, claim or counterclaim by the Administrative Agent for the return of any Erroneous Payments received, including without limitation waiver of any defense based on “discharge for value” or any similar doctrine.”
What is it and what does it do?
Erroneous distribution provisions are included in credit agreements to grant the administrative agent the right to be repaid if it makes an erroneous distribution and to specifically waive the recipient’s right to bring any defenses relating to the erroneous payment. While market practice is evolving, it is an increasingly common protective provision for the administrative agent, and many lending institutions as well as industry groups like the Loan Syndication and Trading Association (LSTA) in the United States and the Loan Market Association (LMA) in the United Kingdom have now developed model language.
Why is it there?
Erroneous distribution provisions have been developed largely in response to a recent New York court case1, which, to the surprise of some in the lending industry, permitted lenders to retain a loan payment made in error. Generally, the law requires mistakenly wired money to be returned. However, there is an exception to this general rule under New York law that allows a recipient to keep mistakenly distributed funds if the funds discharged a valid debt, the recipient made no misrepresentations to induce payment, and the recipient did not have notice of the mistake. Although cases where the exception applies are uncommon, administrative agents have started to insert erroneous distribution provisions into credit agreements to shield themselves from this scenario and mitigate their assumed risk.
Why is it important (or not so important) to Lender?
Erroneous distribution provisions need to be kept in mind by lenders because they may be obligated to agree to: (A) indemnify the administrative agent for any loss it has suffered, (B) waive their rights to bring any defenses relating to accidental distributions, or (C) assign their interests in the loan in favor of the administrative agent in an amount equal to any erroneous payment that is not recovered. In some cases, they may need to pay interest on any retained accidental payment. While, as a general matter, credit agreements already contain broad protective provisions for the administrative agent, lenders need to ensure that the erroneous distribution provisions do not overreach.
How does it affect Borrower in practical terms?
Erroneous distribution provisions are most likely to concern matters between agents and lenders or any person that has received funds on their behalf, but sometimes they are drafted broadly to pick up any person that has received funds. This could mean that any accidental distribution made by an administrative agent to the borrower could fall within the reach of the provisions, and the borrower may be bound by the same obligations and limitations detailed above.
How is it relevant to shipping?
There is nothing unique in the shipping industry that warrants inclusion or exclusion of erroneous distribution provisions in a ship financing agreement. Ship financing lenders, however, do tend to be late adopters of loan market trends, and erroneous distributions provisions can be a useful tool for agent banks engaged in ship finance, as mistakes are sometimes made, especially in smaller financial institutions that do not have an extensive operations department or agency function.
How is it negotiated?
It would be rare for an erroneous distribution provision to be rejected by the borrower or any lender entirely because an administrative agent needs protection in light of the potentially severe consequences of any unintentional error. However, the contours of such provision may be negotiated. For example, accrual of interest on erroneous payments may be resisted, or inclusion of a notice deadline where the administrative agent must notify the lenders of the erroneous payments within a specified period could be insisted.
Questions?
Please contact any member of S&K’s Maritime Practice Team.
